Greater use of renminbi for sovereign borrowing mooted

One of the most hotly-discussed questions in world finance concerns the timing of the expected take-off of the Chinese renminbi as a worldwide financial transaction and reserve currency. International banks all over the world are preparing for a further wave of renminbi activity in coming years as the Chinese authorities gradually release the shackles on the international use of the currency.

Behind the scenes, differences of opinion are building up between China-domiciled banks and securities houses, which wish the Beijing authorities to act more aggressively on liberalisation, and top Chinese financial officials, who take a cautious line because of worries about the possible disruptive monetary effects of extended deregulation.

One way of reconciling these opposing views would be to encourage governments in Europe, including the ESM and EFSF euro area bail-out funds, to use the renminbi in sovereign borrowing on the onshore or mainland renminbi market. This so-called Panda bond sector, which is most used by Chinese borrowers rather than foreign issuers, dwarfs the offshore Hong Kong renminbi bond market – so-called Dim Sum issues – which has attracted significant international attention.

The British Treasury has sporadically toyed with issuing Panda bonds but up to now has rejected the idea as a workable option.

The Panda market is far more important than the Dim Sum sector for China’s long march to establish the renminbi as an international currency. Central banks will invest substantially in a reserve currency only if it is fully convertible and also offers deep and liquid domestic financial markets.

The renminbi at present does not match these criteria, but is encountering heavy demand from reserve managers around the world because of its growing use in international trade settlements and investment transactions. Deepening China’s financial markets would help meet this demand, which one international banker describes as ‘insatiable’.

One Chinese economist says that China and other Asian countries should build up a fully-effective trade settlement infrastructure for local Asian currencies to rival the dollar-denominated SWIFT system. Local currency Asian bond settlement should be added to this system. ‘Full capital market liberalisation may not be a prerequisite for internationalizing currencies,’ the economist said. ‘Renminbi trade settlement is restrictive and controlled but can still contribute to reducing dollar dependence and diversification of settlement currencies.’

Already, some European governments have been making discreet soundings about tapping the mainland renminbi bond market, where total outstanding issuance of around RMB24tn is about 60 times the cumulative figure for Dim Sum bonds.

Of the total, RMB7tn represents corporate bond issues by China’s non-bank sector. The rest is made up of issues by the Chinese finance ministry and banks. So far, western governments have been dissuaded from raising renminbi because of the relatively low cost of borrowing in euros, the dollar or sterling, the difficulty of ‘swapping’ renminbi raised through bond issues into local currencies, and the expectation (now dimmed) that the renminbi will appreciate further in coming years. In addition, debtor governments may fear the stigma of borrowing in anything else except their own national currencies.

However, the attractiveness of renminbi borrowing could increase in the future as European interest rates rise with the gradual withdrawal of central banks’ ultra-easy monetary policies, and international demand for renminbi grows. Landmark issues in mainland renminbi by high-quality European sovereigns, in substantially higher volumes than that commonly seen in Hong Kong, would find immediate favour among central bank asset managers around the world, who are showing increasing appetite for renminbi reserve holdings.

This demand for renminbi among official institutions would bring about several mutually-reinforcing advantages. It would lower the cost of borrowing by cash-strapped western governments, give them a new source of stable longer-term finance, and help fulfil the Chinese authorities’ desire to see a greater role for the renminbi in official reserve holdings. Experts say top quality European governments could raise 10 year bonds in renminbi at 2-3%, similar to yields on the most stable euro members’ debt in euros.

In addition, by promoting the renminbi’s borrowing use by heavily-indebted governments, the Chinese authorities would be arguably promoting world-wide monetary and financial stability. Siphoning off renminbi from the mainland Chinese market into stable long-term reserve holdings would offset Beijing’s concerns that renminbi inflows into China would lead to destabilising currency appreciation that would constrain exports and growth.

Furthermore, western Panda bond issuers would have a natural interest in protecting their currency from depreciating against the renminbi, to lower the cost of debt service payments. The constraint of borrowing in renminbi could therefore act as a disciplinary influence on profligate western governments, backing up general efforts to bring more order into a new worldwide monetary constellation. This would be an intriguing rerun of the position at the end of the 1970s, when the parlous state of the dollar forced the US administration under President Jimmy Carter to issue bonds in the D-Mark and Swiss franc to stabilise the dollar – the so-called ‘Carter bonds’.

The Chinese authorities say they wish the renminbi to gain greater prominence to facilitate financing of cross-border trade and investment and lower China’s dependence on the dollar. However, they are worried that accelerated liberalisation could lead to an over-rapid build-up of offshore renminbi, which could complicate exchange rate and monetary policy management and bring damaging volatility outflows and inflows.

Because of the renminbi’s only slow move towards full reserve currency status, Chinese officials say the world is still a long way from a genuine multi-currency reserve system where the dollar shares its role with other countries in a framework of mutual ‘policy discipline’. They also believe that alternatives for leading reserve currency status, such as an enhanced Special Drawing Right or a new international currency, are not practicable.

They term the set-up that is emerging the ‘1 plus 4’ system in which the dollar, as the dominant currency, co-exists with the euro, yen, sterling and renminbi. In a significant signal of confidence towards the British authorities, a leading Chinese official says: ‘The British pound will continue to be an important player with very special vitality and unique importance. The British empire no longer exists. But London, being located in the middle of east and west time zones, is still the most important financial centre comparable to New York in many aspects. London has the advantage of financial freedom and openness, in foreign exchange trading, international bond issuance and financial derivatives. Ironically the benchmark rate for the US dollar is determinate in London rather than New York: we have Libor not Nibor.’